Tuesday, March 24, 2009

The Law That Dares Not Speak Its Name: Gay Marriage and Taxes

As the Supreme Court of California ponders the validity of Prop 8, let's take a moment and contemplate the variety of tax issues which gay marriage presents, particularly in community property jurisdicitions such as California. Last summer, in the window between the In re MARRIAGE CASES decision, and the passing of Prop 8, approximately 18,000 gay marriages were solemnized in California. In many California counties marriage license applications were amended to denominate the applicants as "Party A" and "Party B" instead of "bride" and "groom." Thus, let's call these A/B marriages for brevity's sake, and refer to husband/wife unions as X/Y marriages.

Had Prop 8 not halted A/B marriages, the anticipated numbers of gay people marrying in California would have been impressive. The Williams Institute at UCLA School of Law estimates that there are 102,639 same-sex couples living in California; 51,319 of those are couples who were projected to marry in the next three years. In addition, it was anticipated that approximately 67,513 same-sex couples from other states would come to California to marry. That means that in just the next three years there might have been more than 230,000 taxpayers impacted by the outcome of In re MARRIAGE CASES.

At the federal level, the Defense of Marriage Act (DOMA) prohibits the recognition of such marriages by any federal agencies, including the IRS. This means that while for California purposes A/B couples incur the tax benefits and burdens of other married couples, they are treated as two unrelated individuals on their federal 1040. What concerns us is that in the "Defense of Marriage" politicians are allowing social policy to trump economic reality, triggering several tax anomalies.

For example, A/B couples are not subject to Code Secs. 267, 318, 1239, and 1041 despite standing in a marital relationship. From a strictly economic viewpoint the advantage of not being tagged with attribution, or being able to sell property at a loss to one's spouse, might mitigate or eclipse the disadvantages of not being able to file a joint return. But regardless of one's political leanings, the refusal to recognize A/B couples as an economic unit is sheer tax folly.

DOMA's tampering with family relationships extends beyond the A/B couple themselves. The basic rule in California is that a child born during a marriage and up to 300 days thereafter is presumed to be a child of both spouses and no adoption is necessary. But if the IRS and other federal agencies don’t recognize the marriage, will adoption be necessary for federal purposes? If no such adoption takes place then how will Code Secs. 267, 318, and 1239 apply to such family relationships? Will such child be considered a child of the taxpayer, and therefore a dependent, under Code Sec.152(c)(2)(A)?

Moreover, in refusing to recognize the legitimacy of a marriage contracted in California, the IRS is also negating the character of property held by A/B spouses as community property. This impinges on the bedrock U.S. Supreme Court doctrine that property rights are characterized under state law. The IRM at 25.18.1.1 states:

"Federal law determines how property is taxed, but state law determines whether, and to what extent, a taxpayer has "property" or "rights to property" subject to taxation. Aquilino v. United States, 363 U.S. 509 (1960); Morgan v. Commissioner, 309 U.S. 78 (1940). Accordingly, federal tax is assessed and collected based upon a taxpayer's state created rights and interest in property. "

DOMA therefore directly conflicts with prior Supreme Court precedent and IRS policy. How will this play out? Will only ½ of community property be liable for the tax debts incurred by one spouse, contrary to how such property is treated in X/Y marriages? To which property will a federal tax lien of a debtor spouse in an A/B couple attach? Will such community property be considered joint tenancy property for federal purposes including inheritance? Tenancy-in-common property? Interestingly here’s what the IRM (at 25.18.1.1.3) says about community property and perhaps illustrates the contradictions in applying the DOMA statute to property owned by A/B couples:

"[t]he natural inclination to think in terms of "his" and "hers" must be discarded with regard to community property. It is inaccurate to refer to community property acquired by the wife as "the wife's income" or to community property acquired by the husband as "the husband's income." These terms have no meaning under community property law and instead reflect the inappropriate application of common law principles. Community property is simply property that both spouses share equally, just as partnership income is income that all partners share equally, regardless of which partner was responsible for acquiring the income on behalf of the partnership. "

Finally, there is another issue we've been pondering. We tend to employ imprecise phrases like “same-sex” marriage, and therefore assume we can categorize a marriage as either same-sex or not. It is actually far more complicated. In the past driver’s license records, as a practical matter, were used to make a determination of sex for purposes of marriage. Thus the state has historically functioned as kind of a “gatekeeper” in not permitting A/B marriages. This is a determination the Feds have relied on and virtually never questioned. But once California allowed gay marriage it no longer considered the sex shown on a driver’s license; it allowed marriage between any two of-age unmarried persons. California did not record whether such marriage was “same-sex.”

With the state not functioning as the “gatekeeper” who will determine whether a marriage is a same-sex marriage for purposes of the federal DOMA statute, IRS definitions etc? Is the IRS going to become the “sex police”, rendering determinations on audit about whether the marriage is of people of the same sex? What documents and standards will be used to determine the sex of the individuals in the marriage? We assume it won’t be driver’s licenses. Are Social Security records going to be used exclusively?

There may be many cases of “civil disobedience” with A/B couples filing joint federal returns. When a joint return is filed by any married couple (X/Y or A/B) will their Social Security #s now be automatically run through the Social Security database to determine whether it is filed by two individuals which Social Security shows are of the same sex?

Regardless of whether you support or oppose gay marriage the tax issues are real, and the answers aren't easy. But sane economic policy, and not personal politics, ought to be paramount in implementing the Code.

3 comments:

Lots more IRC questions out there, which I'm sure are being furiously explored by tenure-seeking tax profs at this very moment. One, from my own past work, that intrigues me is the impact of "A/B" marriage on the "innocent spouse" provisions of IRC Sec. 6013, which includes special rules for spouses in community property states who do not file joint returns.

Hi Steve and welcome to the blog! While I'll share my thoughts about Code Sec. 6015 innocent spouse in a separate post, I think Code Sec. 66(c) may present the bigger issue, at least in community property jurisdictions. A/B couples aren't allowed to file joint returns, but they can and will file separate returns. They will have community income under California law. The Service has indicated A/B spouses cannot split the income regardless of its character as community income. But I'm curious if the same will apply to collections. Will the Service respect the interest of the non-debtor spouse in community property, or will it try to have it both ways (viz. not recognize the marriage, not treat the income as community income, but when it comes to collection suddenly "respect" state law and treat it as community property, 100% available for the debts of the debtor spouse). Seems to me the non-debtor spouse would have a solid wrongful levy claim.